# Risk and Return and Stock Valuation

Please assist me with this problem:

Go to Yahoo! Finance at http://finance.yahoo.com/ and look up the stock information for a publicly traded company of your using. If you already know your publicly traded company's stock symbol, all you have to do is enter the letters in the "Get Quotes" field near the top of the page and then press the "Go" button. If you have a company in mind but don't know its symbol, simply click the "Symbol Lookup" link next to the "Go" button. Type the name of the company you want to find in the "Name" field on the Symbol Lookup page and then click the "Look Up" button. Once you find your company's stock information, you may complete the Dropbox Project below. In order to arrive at a value for the stock, you will gather and use information from Yahoo! Finance (http://finance.yahoo.com).

You will apply the concepts of risk and return by estimating the stock's required return from the CAPM model to arrive at the firm's cost of equity. Once the firm's cost of equity has been estimated, you will use the dividend growth model's constant growth assumptions to value the firm's stock. In addition, you will also use the non-constant growth model to value the stock. You will then compare your calculated stock price (using the preferred methodology) to the firm's traded stock price, and then explain, as an analyst would, whether an investor should purchase, sell, or hold the stock.

Please answer the following the questions about the company you chose.

1. Estimate your firm's expected five-year growth rate by dividing the PEG ratio by the forward looking P/E ratio.

(Hint: Click the "Key Statistics" link in the left navigation bar. The PEG ratio and forward looking P/E ratio for your firm will be listed in the "Valuation Measures" area of the Key Statistics page.)

2. Using the expected 5-year growth rate, what is your firm's next expected annual dividend, D1?

(Hint: D0 is given on the Quotes screen.)

3. Assume that your firm's dividend will grow at a constant rate equal to the expected five-year growth rate. Using the DCF model, what is the firm's stock price? Does it seem like a reasonable estimate?

4. Now, let's try to use the non-constant growth method to value this stock. The long-run constant growth rate of most stocks is expected to be between 3% and 8%. Instead of assuming constant growth starting today, use the five-year growth rate to estimate dividends for the next five years and then assume a long-run constant growth rate between 3% and 8%.

Select a number that makes sense for the industry in which your company operates. What is the firm's intrinsic value now?

6. Consider the estimates from both methodologies. Which methodology is more useful in valuing your company? Offer some explanations for your answer.

7. Now, assume you are an analyst. On the basis of the price estimate calculated using your preferred methodology, would you recommend investors to purchase, sell, or hold the stock. Explain your answer.

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#### Solution Summary

The solution explains hopw to value a stock using the PEG and the dividend discount model

Finance: Bond Valuation, Dividend Discount Model, Return on Preferred Stock, Valuation, Risk

A 1: (Bond valuation) A $1,000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bond's coupon rate is 7.4%. What is the fair value of this bond?

A 2: (Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.60 next year and its dividends are expected to grow at a rate of 6% per year forever. Assuming annual dividend payments, what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%?

A 3: (Required return for a preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividend is non growing. What is the required return on James River preferred stock?

A 4: (Stock valuation) Suppose Toyota has non maturing (perpetual) preferred stock outstanding that pays a $1.00 quarterly dividend and has a required return of 12% APR (3% per quarter). What is the stock worth?

B 16: (Interest-rate risk) Philadelphia Electric has many bonds trading on the New York Stock Exchange. Suppose PhilEl's bonds have identical coupon rates of 9.125% but that one issue matures in 1 year, one in 7 years, and the third in 15 years. Assume that a coupon payment was made yesterday.

1. If the yield to maturity for all three bonds is 8%, what is the fair price of each bond?

2. Suppose that the yield to maturity for all of these bonds changed instantaneously to 7%. What is the fair price of each bond now?

3. Suppose that the yield to maturity for all of these bonds changed instantaneously again, this time to 9%. Now what is the fair price of each bond?

4. Based on the fair prices at the various yields to maturity, is interest-rate risk the same, higher, or lower for longer-versus shorter-maturity bonds?

B 18: (Default risk) You buy a very risky bond that promises a 9.5% coupon and return of the $1,000 principal in 10 years. You pay only $500 for the bond.

1. You receive the coupon payments for three years and the bond defaults. After liquidating the firm, the bondholders receive a distribution of $150 per bond at the end of 3.5 years. What is the realized return on your investment?

2. The firm does far better than expected and bondholders receive all of the promised interest and principal payments. What is the realized return on your investment?

B 20: (Constant growth model) Medtrans is a profitable firm that is not paying a dividend on its common stock. James Weber, an analyst for A. G. Edwards, believes that Medtrans will begin paying a $1.00 per share dividend in two years and that the dividend will increase 6% annually thereafter. Bret Kimes, one of James' colleagues at the same firm, is less optimistic. Bret thinks that Medtrans will begin paying a dividend in four years, that the dividend will be $1.00, and that it will grow at 4% annually. James and Bret agree that the required return for Medtrans is 13%.

1. What value would James estimate for this firm?

2. What value would Bret assign to the Medtrans stock?

Problem: (Beta and required return) The risk less return is currently 6%, and Chicago Gear has estimated the contingent returns given here.

1. Calculate the expected returns on the stock market and on Chicago Gear stock.

2. What is Chicago Gear's beta?

3. What is Chicago Gear's required return according to the CAPM?

Realized Return

State of the Market Probability that State Occurs Stock Market Chicago Gear

Stagnant 0.20 (10%) (15%)

Slow growth 0.35 10 15

Average growth 0.30 15 25

Rapid growth 0.15 25 35